The Three Cs of Equipment Leasing

Paul Bosley is national marketing director for First Financial. His health club industry experience includes working for Titan Management Co., Healthclubexperts.com, Q Sports Clubs and Bally HTCA/Holiday Health & Fitness Centers. He has a bachelor’s degree in Health Science & Recreation Management and is studying to get his associate’s degree in accounting. He has spoken at the Club Industry and International Health, Racquet & Sportsclub Association conferences.For more information about leasing, please contact Paul at (800) 956-7313 or by e-mailing paul@ffash.net.

In today’s lending environment, I am asked frequently if any lending is being done. The good news is that lending is indeed being done. The bad news, however, is that as a direct result of our prolonged recession, many funding sources have gone out of business and have exited the leasing business. This erosion of lenders has put additional demand on those remaining funding sources that have a finite amount of capital to lend. As a result, the underwriting criteria of remaining lenders to approve a lease application have become more stringent.

In a typical lease transaction, the security collateral offered to a lender is the fitness and nonfitness equipment being leased. The value of the leased fitness equipment depreciates immediately after installation. When you consider a fitness center lease from a lender’s perspective, what do you think the fitness equipment is worth if the lease defaults and if the lender tries to resell it after two years of use? Considering what remanufactured fitness equipment typically sells for compared to new machines, it falls to about 50 percent of the value.

In some cases, major equipment vendors will guarantee a lease approval for a lender to secure the sale of their line of equipment on a recourse basis. In these cases, the lender is approving the lease transaction based upon the lease application with the understanding that in the case of a default, the vendor will remove the equipment and make the lender whole. This service is a profit center when the lessee pays as promised and a cost of doing business in the case of a default to the equipment company.

Club owners also need lockers, security systems, computer systems, software, removable flooring, refrigeration equipment, vending machines and signage to build a new club or to remodel an existing fitness center. Because a club owner needs this equipment in the normal course of conducting business, these items can be included in the lease as a soft cost rather than a hard asset since they have more limited resell value in the case of a default.

The keys to lease approvals are cash flow, credit and collateral.

Cash Flow – The key to receiving a lease approval is positive cash flow. Most underwriters’ formulas add net income to a portion of depreciation (since depreciation is a noncash expense) and the resulting free cash flow must exceed the amount of the annual lease payments for the amount requested in the lease by some margin. As an example, if the company shows a $75,000 net income with $50,000 in depreciation, an underwriter may consider that at least $100,000 is available to repay the new lease. If the lease request requires annual lease payments of $50,000, the lease probably will be approved. If the lease payments require annual lease payments of $120,000, the request will be denied because the cash is not there based upon history to repay the new lease. Typically, the only documents accepted by lenders to verify cash flow are tax returns, financial statements prepared by CPAs and business bank statements. Internally prepared statements are only considered when a company shows a history of net income on a consistent basis.

Credit – Business credit scores for companies are recorded by Dunn & Bradstreet and Paynet. All existing club owners should periodically check that the information reported about your company is correct. The lease transaction is guaranteed by all owners with more than a 10 percent equity position in the company. Consequently, personal credit plays a large role in lease approvals. A 700-plus credit score is now required from “A” lenders, and credit scores of 650-plus are typically required by “B” lenders. The biggest differences between “A” and “B” lenders are that “A” lenders will approve leases for higher amounts and the monthly payments are less per thousand. Understanding this concept is a key in determining the effect of partnerships on a corporation.

Collateral – Not everyone has a 650-plus credit score, and not everyone owns a company that reports a net income. Some funding sources offer leases to applicants who offer collateral in addition to the equipment being purchased. Collateral typically is in the form of marketable stock, CDs or real estate. In the cases of real estate, lenders use a formula to reduce the stated amount of the property, and from that amount, an outstanding mortgage is reduced to determine the security amount offered. As an example, if a property is appraised at $250,000, the underwriter reduces the amount by 20 percent to $200,000. If there is a $100,000 mortgage on the property, the collateral considered on the lease is $100,000. Generally, if the property has more than one mortgage, it will not be considered as collateral for a transaction.